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Franchise Law Update

Commentary on Business and Legal Issues of Franchising

Vicarious Liability: Can We Breathe a Sigh of Relief after Patterson? (No)

Posted in Legal Decisions

It hasn’t been a great summer for the issue of vicarious liability in franchising. In particular, the Office of General Counsel of the NLRB, in its McDonald’s recommendation, has demonstrated that it is hostile to the franchising model of business. So many of us were rightly concerned about how the California Supreme Court would rule in Patterson v. Domino’s Pizza, LLC. [PDF].

The facts of the case are terribly unfortunate. Taylor Patterson obtained a job at a local Domino’s franchise in Southern California owned by a company called Sui Juris, LLC. Ms. Patterson alleged that a shift manager sexually harassed her whenever she and he shared the same shift. We can all agree that the alleged conduct was outrageous. Ms. Patterson claimed that the manager made lewd comments, and grabbed her breasts and buttocks. When the manager refused to stop, Ms. Patterson reported the conduct to the owner of Sui Juris and her father. She stayed away from work for one week. When she returned, she perceived that her hours had been cut in retaliation for reporting the harassment.

30014105_sPatterson’s father called a 1-800 customer complaint line set up by Domino’s and reported what had happened to his daughter. In this manner, one of the key factual issues in the case developed. As a result of that call, the information was passed to a Domino’s “area leader” for over 100 franchisees in Southern California. In discussing what had happened to Patterson with the franchise owner, the area leader allegedly told the owner, “You’ve got [to] get rid of this guy.” Importantly, the franchise owner testified that he saw no specific implication in the remarks of his area leader nor did he ask what would happen if he didn’t fire the manager. Ultimately, the manager stopped showing up for work, resolving the issue in the mind of the owner.

Nonetheless, the area leader’s statement became a significant issue in the case after Ms. Patterson sued, naming not just the franchisee but the franchisor as well. Domino’s sought summary judgment, stating that it was not an employer or principal of the manager, and that it could not be held vicariously liable as a result. The trial court agreed, but then the Court of Appeal reversed, holding that there was a triable issue of fact as to whether Domino’s was an employer or principal for vicarious liability purposes. The Court of Appeal seemed to give particular weight to the “get rid of this guy” statements of the area leader, along with the franchisee’s testimony that he followed her instructions.

The Supreme Court, after a careful and nuanced review of the franchising business model and vicarious liability law involving franchise systems, concluded that the trial court had been correct; Domino’s was not the employer or principal of the manager who committed the harassment of Ms. Patterson. The Court focused on the means and manner test: an agency relationship exists only where the principal dictates, not just the desired result of the enterprise, but also the manner and means by which the result is achieved. The Court held that a comprehensive operating system alone does not constitute the amount of control necessary to support vicarious liability claims like those raised by Ms. Patterson.

With respect to personnel issues, the Court found that Domino’s franchisees are owner-operators who hire and train the people who work for them, and who oversee the performance of those employees every day. In fact, in this Court’s view, a franchisor only becomes potentially liable for the actions of the franchisee’s employees if it retains or assumes a general right of control over factors such as hiring, direction, supervision, discipline, discharge and relevant day-to-day aspects of the franchisee workplace. Moreover, in reviewing the evidence, the Court found that Domino’s had no contractual authority to manage the behavior of employees and, in fact, that it did not have any such actual authority either. Domino’s was not involved in the application, review or hiring processes of its franchisees.  The franchisee was also solely responsible for training employees on how to treat each other at work and how to avoid sexual harassment.

So, a win for franchising? In the immediate term, yes. But I see significant potential long-term issues with the Supreme Court’s opinion. First, the Court essentially authored a roadmap for lawyers looking for ways to sue franchise systems on grounds of vicarious liability. Franchisors should take a hard look at their systems, training programs and operating manuals–particularly if they are operating in California–to absolutely ensure that they do not control the manner and means where agency could be an issue.  Second, training of regional representatives, area leaders, and the like should emphasize that business areas left to the franchisee’s control must be left to the franchisee’s control. While the majority opinion accepted the testimony of the franchisee that he saw no implication in the “get rid of this guy” statement, the Court of Appeals and especially the dissenters on the Supreme Court seized on this comment. Unless it is truly a branding matter, it is best that the franchisor’s representative stay out of the fray.

And that brings me to the third and most troubling issue. The dissenters, who would have found vicarious liability, pointed to the fact that the Domino’s area leader once told the franchisee in this case to have a manager stop using Domino’s-branded bags to deliver a competitor’s food as further evidence of Domino’s control over personnel decisions. Huh? That’s right: what seems like a clear branding matter to a franchise professional is a personnel issue to three members of the California Supreme Court. Now, let me add that the Supreme Court decision was 4 to 3. One person changes sides, and this is a completely different (and very troubling decision).

Or Maybe We Won’t . . . (Heigl v. Duane Reade–Update)

Posted in Business Updates, Legal Decisions

A few months ago, I blogged about the complaint filed by Katherine Heigl against Duane Reade. Ms. Heigl complained that Duane Reade had improperly used a picture of her carrying bags from the drugstore chain snapped by paparazzi in posts at social media outlets like Twitter and Facebook. The allegation was that the photo and accompanying language amounted to an unauthorized celebrity endorsement of Duane Reade by Ms. Heigl.

To me, the case presented fascinating questions at the intersection of first amendment (free speech), social media and false advertising law. The picture of Ms. Heigel was taken in a public place, where celebrities generally have little privacy protection. On the other hand, the case was brought in New York which has significant protections for celebrity images used in advertising. Moreover, Duane Reade might have crossed a line when it copied the photo from a celebrity gossip site and removed the accompanying story.

Alas, however, we won’t be getting any legal answers on these issues from this case because Ms. Heigl’s attorneys have voluntarily withdrawn the lawsuit. While the terms of any settlement are confidential, according to media reports, Duane Reade will make an undisclosed contribution to the Jason Debus Heigl Foundation in exchange for the decision to end the case. As questions regarding the appropriate use of celebrity images in social media will continue to fester–and provide potential headaches for franchise social media managers–I’ll be on the lookout for additional cases which might provide answers.


UPDATE: California Senate Approves and Sends Franchise Act Amendment Bill to Governor

Posted in Legislative Updates

SB610, approved by California’s assembly earlier this month, was given final approval by the California senate late last week in a vote of 23-9 and sent to Governor Jerry Brown for signature to become law.

As we reported shortly after SB610′s approval by California’s assembly, the bill will amend the California Franchise Relations Act (Act) to make it more difficult for franchisors to terminate or fail to renew franchisees.  If signed into law by the Governor,  the Act will be amended to make it unlawful for a franchise agreement to:

  1. restrict the right of a franchisee to join a franchisee association;
  2. prohibit a franchisee from transferring a franchise to a qualified person or allow a franchisor to unreasonably withhold consent to a transfer;
  3. terminate a franchisee prior to the expiration of its term, except upon a substantial and material breach on the part of the franchisee of a lawful requirement of the franchise agreement; and
  4. terminate a franchisee for a  substantial and material breach without allowing 30 days to cure the breach.

SB610 is strongly opposed by the International Franchise Association which argues that approval of the bill will result in less individually owned franchises and more company-owned outlets in California.  You can read the statement issued  by the IFA after the bill’s passage here.  The bill was sponsored by the Southern California-based American Association of Franchisees and Dealers and supported by franchisees and labor unions such as the Service Employees International Union (SEIU) who argues that a shift in power to individual franchise owners will ultimately help workers.

Service Animal or Playful Pet? Complying with the American with Disabilities Act

Posted in Regulatory Compliance

This week a Florida restaurant made the wrong kind of news when a couple with service dogs was asked by the manager to leave the premises.

This isn’t the first time that a business has gotten bad press for refusing service to persons with animals. But what do you do in age where homeowners sue to keep service miniature horses in their homes in violation of city ordinances and passengers cart snakes onto buses and planes using the Americans with Disabilities Act (“ADA”) as a shield? Add in the new trend of emotional support pets, it can be hard for a business to know what it can legally prohibit.  How does a franchisee know when a customer has a genuine reason for being accompanied by an animal or is trying to circumvent a legitimate “NO PETS” policy?

Under the ADA a business is permitted only to ask the following questions of a customer or patron with a service animal:

  1. Is the animal required because of a disability?
  2. What task or service has the animal been trained to do?

This makes it hard for businesses to ferret out who is the “real deal.”  People can, and often do, lie.  Unfortunately, a business can’t try to verify the veracity of a customer’s statement. A business may NOT insist on any type of “proof” such as a state certification before permitting a service animal.  A business (such as a hotel) cannot charge a maintenance or cleaning fee for customers with service animals. The most important to thing to remember is a service animal is NOT a pet or treated as one under the law.

There are certain exceptions such as when an animal’s behavior poses a risk to other patrons (for example, vicious snarling) or if accommodating the service animal will result in a “fundamental alteration of the business” (for example, loud barking during a movie).

Almost every franchise agreement will have general language requiring that franchisees comply with all laws, regulations and rules governing the franchised business. In many cases, ADA compliance is specifically referenced in the franchise agreement. But it can be difficult for a small business to navigate the intricacies of these laws.

As franchise systems know, a single unlawful act by one franchisee — even if unintentional — can taint the whole brand if the story goes viral.  Therefore, a franchisor should consider doing the following:

  1. conduct periodic training sessions or seminars at your annual convention for franchisees on ADA compliance;
  2. ensure that your Operations Manual contains detailed requirements that management know how to obey and comply with these laws on a practical everyday level;
  3. remind franchisee management that it is their responsibility to ensure that all employees do not inadvertently violate the law; and
  4. keep updated on changes in the law.  In particular, the ADA was revised in 2011 to recognize only dogs as service animals.  This is not the case, however, under other laws such as the Fair Housing Act, Air Carrier Access Act or certain state or local laws. It is important to reach out to your legal counsel with compliance questions.

It is becoming more common to see these types of issues arise. In fact, a colleague practicing in animal law recently told me of a member of the audience in a seminar she spoke at who had a service spider! Smart franchise system must have plans in place so as to be prepared to deal with these issues.

Are You Ready for Smart Chip Credit Cards?

Posted in Business Updates

The Wall Street Journal today is reporting that US credit card issuers will distribute more than 575 million smart chip credit cards by the end of 2015.  That’s approximately one-half of the one billion credit cards in circulation in the United States. The distribution of chip cards–in wide use throughout the rest of the world–has been hampered in the US by a chicken-and-egg problem. Because the US consumer and retail marketplace were early adopters of credit card payment systems, the US has a massive infrastructure supporting the old-tech magnetic strip cards. Retailers have been unwilling to introduce the new technology until consumers have the chip cards in their wallets; banks have been unwilling to issue chip cards until consumers have a place to use them.

Now, spurred by massive data breaches involving credit cards like the one that hit Target last year (interestingly enough, Target was an early adopter of smart chip cards in the early 2000s but abandoned the effort after other retailers failed to follow suit), the tide has seemingly turned. The advantage of the chip card is that each transaction has a unique code attached to it, making a stolen credit card number alone useless to thieves. The WSJ article notes that the biggest retailer in the US, Wal-Mart, has installed the new technology at 4,600 of its stores and expects to complete the changeover at all 5,000 of its locations by year’s end.

Franchisors and franchisees will be on the front lines of this massive switchover to the new technology. And it sounds like both patience and some new employee training will be required. In particular, you do not simply “swipe” the new cards. Instead, they are inserted into the card reader and stay there until the transaction is completed. In some cases, moreover, the entry of a PIN will be required. While the switchover will probably entail some bumps along the way, smart chips are likely to become the industry standard for fraud prevention in the US, as they have in the rest of the world. Moreover, Visa and MasterCard announced that any actor–retailer or card issuer–without chip technology in place by October 2015 will bear the cost of fraud committed on their networks.  Therefore, adoption of and compliance with smart chip card technology will almost certainly become necessary for risk and liability avoidance in a short period of time.

Pennsylvania Based Franchise System Developing Marijuana Pizza Sauce

Posted in Business Updates

Last week I posted my opinion that I thought it was unlikely that 2014 has the potential to be the year of the marjiuana franchise.  I continue, however, to see more and more franchisors looking for22161705_l creative ways to incorporate marijuana into their systems in the almost two dozen states that permit the sale of marijuana for either medical or recreational use.

Unique Pizza and Subs is just one of those franchise systems.  The Pennsylvania based pizza franchise recently announced that it is in the process of developing a new “cannabis infused” signature pizza sauce.

There is no marijuana sauce yet on the menu but if the “marijuana infusion chefs” retained by the franchise system have any luck it won’t be long.  The press release states that Unique Pizza and Subs will work with local manufacturers to produce the product in compliance with all applicable state laws if and when it is developed.  There is no news yet on whether the pizza system intends to license the products to franchisees in states where medical or recreational use of marijuana edible products is legal.   Currently Unique Pizza and Sub has locations in Pennsylvania and Michigan and, of those two, only Michigan allows legal marijuana possession and then only for medical purposes.  There is no doubt that it will be interesting to see how Unique Pizza and Subs addresses the new and unusual franchise disclosure and relationship issues should it decide to move forward with licensing the product to its franchisees.

It May Soon Be Much Harder to Terminate Franchisees in California

Posted in Legislative Updates

Yesterday California’s assembly passed Senate Bill 610 amending the California Franchise Relations Act (Act) to make it more difficult for franchisors to terminate or fail to renew franchisees.  SB610 was passed by the California senate last year and now goes back to the senate for final approval.

The fate of SB610 has been closely monitored during this summer of seemingly non-stop hits against large franchisors.  After the NLRB General Counsel’s office opined that McDonald’s can be a joint employer with its franchisees and Seattle implemented a minimum wage law treating small business franchisees as large franchise systems, this is yet another blow to franchisors.   The International Franchise Association and the California Chamber of Commerce fought a hard campaign against the bill but it wasn’t enough.

If the California senate gives final approval, the Act will be amended to make it unlawful for a franchise agreement to:

  1. restrict the right of a franchisee to join a franchisee association;
  2. prohibit a franchisee from transferring a franchise to a qualified person or allow a franchisor to unreasonably withhold consent to a transfer;
  3. terminate a franchisee prior to the expiration of its term, except upon a substantial and material breach on the part of the franchisee of a lawful requirement of the franchise agreement; and
  4. terminate a franchisee for a  substantial and material breach without allowing 30 days to cure the breach.

Opponents to SB610 quickly point out that the proposed law is unclear and restricts a franchisors ability to protect its goodwill, name and brand.  I agree.   Does anyone know what will constitute a ”substantial and material breach?”  Is it fair for a franchise system to be forced to accept a transferee that may not be good fit despite being otherwise technically “qualified?”  These and many other issues are likely to arise if SB610 becomes law.

Bans on Corporate and Association Political Contributions in Pennsylvania Permanently Enjoined

Posted in Legal Decisions

In a decision largely dictated by the U.S. Supreme Court’s decision in Citizens United, U.S. District Judge William Caldwell of the Middle District of Pennsylvania today entered a permanent injunction suspending the Pennsylvania state law barring corporations and associations from making political contributions.

Judge Caldwell did not, however, agree to the Commonwealth’s request to create a new category of “independent political committees” in Pennsylvania.

This decision obviously has significant implications for franchisors and franchisees operating in Pennsylvania, who can now make direct political contributions to candidates from their corporate entities. As there are expected to be fierce fights this fall over the Governor’s Mansion and both houses of the Commonwealth’s Legislature–and increased franchise regulation is a regular topic in Harrisburg–I expect the franchise community will use this new opportunity to have its voice heard by the politicians.

Looking to Grow a Marijuana Franchise?

Posted in Business Updates, Industry Updates, Legislative Updates

Doggy daycare resorts, bed bug chasers, hypnosis centers- what hasn’t been franchised?  Many attorneys, myself included, represent franchisors in a very wide variety of industries all over the United States.  What happens when you get that call from a client saying “I want to franchise my marijuana business!”

The marijuana franchise trend has already started to take off driven by the creative spirit  of ‘ganjapreneurs’. Ear15200982_llier this month Fuel Fuels, Inc. sold its first Cafe Serendipity franchise which offers a wide variety of marijuana products, accessories, edibles and beverages. Cafe Serendipity plans to eventually roll out franchises all over United States believing that it can grow its market share by offering consistently quality products. Colorado based brothers Andy and Pete Williams are discussing turning their medical marijuana dispensary, “Medicine Man” into a Las Vegas franchise. weGrow, a supersized store offering a wide selection of hydroponic growing equipment to the marijuana industry started offering franchises in 2010.

So is 2014 the year where franchising in the marijuana industry is set to take off?  Answer: Probably not.

First and foremost, marijuana is still illegal under federal law.   As the Franchise Times questioned at the start of the medical marijuana movement can a franchise system be successful when the Franchise Disclosure Document has a risk factor stating that Under federal law, operating this franchise is a felony punishable by a minimum five-year prison sentence? Two years ago, the American Bar Association’s  The Franchise Lawyer published an excellent article detailing the pitfalls and legal perils of franchising a marijuana business.  The article emphasized the need address a whole host of potential roadblocks and touches upon such important legal issues as:

  1. Whether legal advice from an attorney to a marijuana franchisor or franchisee client about its business venture loses the attorney-client privilege under the “crime-fraud” exception which states that communications made to perpetrate a crime are not protected given that the whole business itself violates federal law?
  2. What are the federal tax implications?  Can a marijuana franchise deduct business expenses when the tax code prohibits costs related to trafficking controlled substances?
  3. What risks are disclosed in the FDD and what happens if the operation manual conflicts with law?

As this industry grows, budding new legal issues will continue to pop up.   It is clear, however, that any prospective franchisor or franchisee client must find legal representation that can navigate not just the franchise regulatory legal matters, but also tax laws, ethics laws and state and local statutes.  We will continue to keep you updated on this interesting topic as new legal precedent is established, even if we likely won’t be enjoying the fruits of the first ganjapreneurs!

When Does a Franchisee Become an Employee of the Franchisor?

Posted in Industry Updates, Legal Decisions

Contributed by Christina A. Stoneburner

coffeebreak MGD©United District Court Judge Renee Bumb of the District of New Jersey has denied a motion to dismiss claims [PDF of opinion] by four franchisees against their franchisor which allege violations of the FLSA and the New Jersey Wage and Hour Act. 7-Eleven had moved to dismiss the claims based on the fact that the franchisees were not employees of 7-Eleven.

This is really the first shot across the bow filed by 7-Eleven so it is hard to tell where this case will wind up, whether the franchisees will ultimately be found to be employees of 7-Eleven, or whether there were in fact any violations of wage and hour laws.  However, the case brings up an interesting issue of which franchisors should be aware, which is in Judge Bumb’s analysis of who is an employee for purposes of the Fair Labor Standards Act.

The Third Circuit has taken a very expansive view of who is an employee under the FLSA and has instructed courts to look at 6 factors to determine if an individual is an employee.

Those factors are as follows:

(1) the degree of the alleged employer’s right to control the manner in which the work is to be performed;

(2) the alleged employee’s opportunity for profit or loss depending upon his managerial skill;

(3) the alleged employee’s investment in equipment or materials required for his task, or his employment of helpers;

(4) whether the service rendered requires a special skill;

(5) the degree of permanence of the working relationship; and

(6) whether the service rendered is an integral part of the alleged employer’s business.

In the Naik case, the judge was constrained for purposes of the motion to dismiss to accept Plaintiffs’ facts as alleged to be true.  The Plaintiffs alleged a pervasive amount of control by 7-Eleven, including items that may routinely be in franchisor agreements, such as a requirement that the franchisee use only approved vendors and strict directions regarding uniforms and store maintenance.  Often controls over these items are put into place to insure a uniform customer experience and so as not to dilute the franchisor’s brand.  The basic legal rule is that quality control measures expected to be followed by franchisees to insure uniformity does not generally make the franchisor the employer of the franchisee.

The Plaintiffs in Naik allege more than those quality control measures, however.  They allege that 7-Eleven controls all product pricing decisions, controls all bookkeeping, restricts the withdrawal of revenues, runs the franchisees’ employee payroll, and dictates advertising and marketing strategy.  Based on these allegations, Judge Bumb found that the Plaintiffs may be able to prove that they were employees of the franchisor.

Franchisors should be aware that the more controls that they exercise over a franchisee may lead to findings that they are an employer or joint employer for purposes not only of wage and hour laws, but discrimination laws as well.  In those cases where strict controls are exercised, franchisors should pay special attention to whether their franchisees are complying with these laws to try to avoid liability.